Course Project

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The Impact of the 2008–2009 Fiscal Crisis on Venture Capital

The 2008-2009 financial crisis had a significant impact on venture capital. According to Block & Sandner (2009), the crisis decreased average funds by 20%. Notably, it decreased the number of jobs available, doubling unemployment rates. Employment is a vital dataset in capital investment in U.S different firms. Also, the financial crisis led to the loss of wealth and property as the stock market plummeted. According to Merle (2018), Americans lost $9.8 trillion in wealth following a decline in home value and retirement accounts. The paper will focus on the short and long-term impacts of the 2008 financial crisis on VC funding that extended to current players.

The fundamental cause of the 2008 crisis was the collapse of the housing market. Various factors, including low borrowing rates, loose credit regulations, and exaggerated speculation about the industry, contributed to the market's collapse. The concept of ‘liar loans’ encouraged investors to borrow more and refinance real estate investments (Trevino & Nelson, 2021). When house prices fell, many homeowners lost their wealth and defaulted on loans.

The major issues during the crisis include deregulation, cheap borrowing, bank securitization, failure of rating agencies and rise of high risk borrowers. Loose regulations in the financial industry allowed banks to trade in hedge funds by demanding more mortgages to support skyrocketing demand in real estate. The interest-only loans made borrowing affordable to subprime borrowers, who later defaulted on their mortgages and derivatives. These problems could have been avoided by carefully assessing the creditworthiness of borrowers, monitoring the soundness of securities, including securitized mortgage products, and purchasing bad loans by the government.

Federal Reserve, central banks, regulators, and policymakers undertook various measures after the 2008 crisis. These institutions were forced to adopt more effective and safer policies, including adjustments in bank structure and capacity, developing reliable and relevant valuations and disclosure of risks, building resilience, and monitoring money in circulation. The Financial Stability Board (FSB) created an implementation monitoring regime to ensure agreed reforms were implemented. Today, banks have become highly capitalized, and less money flows around the global financial system (Lund et al., 2018). Also, Fed was given more powers to make systematic changes on shadow to cushion banking systems and protect consumers. The government created The Dodd-Frank Act to strengthen regulatory measures in the financial industry.

In addition to the short-term adverse impacts, the crisis has reduced potential output in the long term in investment. After strict regulatory measures and economic restructuring, lower capital accumulation has affected current players including VCs, LPs, and entrepreneur founders. For instance, the credit constraints have slowed capital allocation and locked resources in unproductive activities, hurting investors’ growth. Also, the shift in attitudes towards risks triggered by tight credit conditions and increased capital costs have curtailed physical investment and innovation.

VCs and entrepreneurs protect themselves by doing due diligence, building a network with good startup counsel, and filing federal intellectual property registration. Venture capitalists utilize business concepts and plans, risk judgment, market opportunity, and management teams to evaluate new ventures. This set of criteria allow VCs to mitigate risks by connecting funding with the right entrepreneurs. Entrepreneur founders often obtain venture capital financing by hunting for capital ventures, evaluating them, negotiating and executing the plan. Entrepreneurs should choose capital ventures that ensure sustainable capital and foster economic growth. Overall, building relationships with leading VCs can promote an entrepreneurial community that helps spur start-up activity.

References

Block, J., & Sandner, P. (2009). What is the effect of the financial crisis on venture capital financing? Empirical evidence from US Internet start-ups. Venture Capital, 11(4), 295-309. https://doi.org/10.1080/13691060903184803

Lund, S., Mehta, A., Manyika, J., & Goldshtein, D. (2018). A decade after the global financial crisis: What has (and hasn’t) changed? McKinsey & Company. https://www.mckinsey.com/industries/financial-services/our-insights/a-decade-after-the-global-financial-crisis-what-has-and-hasnt-changed

Merle, R. (2018). A guide to the financial crisis — 10 years later. The Washington Post. https://www.washingtonpost.com/business/economy/a-guide-to-the-financial-crisis--10-years-later/2018/09/10/114b76ba-af10-11e8-a20b-5f4f84429666_story.html

Trevino, L. K., & Nelson, K. A. (2021). Managing business ethics: Straight talk about how to do it right. John Wiley & Sons.